Horrors of Budget 2004 are greatly exaggerated

Economics: There was a time when speculation about the upcoming Budget would not surface until autumn, but the move to a December budget date has brought everything forward; the rumour mill now kicks into gear as early as July.

The pre-Budget commentary and rhetoric is also acquiring some of the ritualistic elements of Budget day itself, with wild predictions of tax increases here and spending cuts there, as well as the grim warnings that this year's Budget will be the toughest for 15 years.

As I recall the latter claim was made last year as well, although, for many, the 2003 budget turned out to be much ado about nothing.

I suppose politicians have only themselves to blame for the hype surrounding the Budget, by fuelling the notion that the State can cure all ills, eliminate poverty, and make us all happy, with a judicious drop of spending here and a dollop there.

This may explain the sense of anti-climax which usually attends budget presentations.

The reality is, of course, that the annual budget can only have a relatively small influence on the economy.

It merely transfers income from one set of individuals - taxpayers - to others, the recipients of government spending, who are generally the same people.

The State can, for a time at least, spend more than it takes in through taxation but even this is now circumscribed by the Stability Pact.

The pact states that governments in the euro zone can borrow only up to 3 per cent of national income in any one year.

In theory, at least, this ability to run an unbalanced budget for a time can be useful, by propping up demand in a slowing economy, for example.

In reality, the downturn tends to be upon us before the Government can change policy.

And politics often intervenes, with spending dictated as much by the electoral cycle as the economic cycle, although these can coincide - the increase in public sector employment in 2001 and 2002, for example, was a welcome development to offset a weaker trend in private sector employment.

Before turning to the 2004 budget, it is worth noting two interesting aspects of the 2003 variant.

The first relates to the planned rise in current voted spending, which covers the areas of most immediate reliance to Irish residents, including public sector pay and the provision of health and education.

This was projected to rise by 8.4 per cent and, as such, was broadly in line with the forecast rise in tax revenue of 8 per cent. Compare this to 2001 which saw spending rise by around 22 per cent despite tax revenue growth of only 3 per cent, and 2002 when spending again substantially outstripped tax revenue growth - this time rising by 15 per cent against 5 per cent on the tax side.

So the 2003 budget brought spending back into line with revenue for the first time since 1994 (for most of the intervening period tax revenue grew faster than spending).

The 2003 budget is also likely to be remembered as the first to return to borrowing since 1997, albeit to fund the National Development Plan

Fortunately, any speculation about the likely shape of Budget 2004 can be shaped by reference to the figures projected by the Minister for Finance himself in last year's budget documentation.

This projected tax revenue growth of 6.1 per cent or €1.9 billion in 2004, based on the assumption that gross domestic product would grow by 7.4 per cent in nominal terms (4.1 per cent real growth and a 3.3 per cent rise in prices).

This may turn out to be pessimistic if the US economy recovers as quickly as the markets now expect.

Yet there appears to be a widely held belief that this tax assumption is too optimistic, a belief based on two false premises - that gross national product determines the tax base (it excludes multinational profits which of course are taxed) and that last year's flat GNP reading is likely to be repeated in 2004.

On the spending side, the Minister had pencilled in a 6 per cent rise in voted current expenditure but this does not allow for a €600 million contingency reserve which, if added in, brings the rise in voted current spending to 8.4 per cent or €2.1 billion which will buy more than in 2003 thanks to lower inflation.

The projected spending figures on the capital side incorporate a 6.2 per cent rise in capital spending, compared to a 1.5 per cent fall in 2003, so if one adds the two, capital and voted current, government spending is projected to rise from €30.8 billion in 2003 to €33.3 billion in 2004, a rise of €2.5 billion or 8.1 per cent.

Should all this pan out as projected, it leaves the Exchequer with a borrowing requirement of €3.5 billion and a general Government deficit (that is, taking account of the transfer of revenue to the State Pension Fund) of €1.8 billion or 1.2 per cent of GDP.

How then does a budget which sees spending accelerating in real terms, a fall in the tax share of GDP and a small deficit equate to the nightmare currently set before us?

Dr Dan McLaughlin is chief economist with Bank of Ireland